The Executive Board of the International Monetary Fund (IMF) on August 31 approved a three-year SDR 51.7 million (to aboutUS$75.8 million) Stand-By Arrangement for the former Yugoslav Republic of Macedonia to support the country's economic program and approved an extension to the obligations schedule of the country's repayments to the Fund in the total amount of SDR 5.4 million (about US$7.9 million).

The approval of the arrangement enables FYR Macedonia to draw SDR 10.5 million (about US$15.4 million) immediately. The authorities have indicated that, after making the initial purchase, they do not plan to draw under the arrangement and intend to treat the arrangement as precautionary.

"The authorities of the former Yugoslav Republic of Macedonia are to be commended for their sound macroeconomic policies: fiscal discipline has kept the debt ratio low, while the de facto exchange rate peg has brought inflation close to zero. However, structural impediments have led to relatively weak economic growth, persistently high unemployment, and a wide current account deficit. The authorities' strong program focuses on structural reforms aimed at increasing growth and employment and reducing the external imbalance, while securing the past gains in macroeconomic stabilization. The program also supports the process of integration with the EU, and is expected to allow for an orderly exit from long-term financial engagement with the Fund. The recent upgrading in FYR Macedonia's credit ratings is encouraging.

"A core program element is an ambitious labor market reform, which should bring down non-wage labor costs and allow for a more efficient allocation of resources. The reform should help draw employment out of the grey market, thus ensuring that labor enjoys legal protections while also contributing to increased revenue collection. A comprehensive judicial reform to strengthen the rule of law and bring the court system closer to European standards will further improve the business climate. These reforms and other measures in the program should lead to higher investment, including foreign direct investment, and lay the basis for stronger growth and employment creation.

"The program's fiscal policies will sustain the adjustment already achieved, keeping the government debt ratio on a declining path, including through the planned broad-based containment of expenditures. Structural fiscal reforms, including the consolidation and rationalization of the collection of payroll taxes, and measures to improve budget planning and execution, will strengthen the efficiency of government operations over time. In the same vein, the authorities have begun to confront long-standing problems in the health sector, signaling a renewed commitment to fiscal integrity and budget management in this sector.

"Monetary policy will continue to rely on the de facto peg of the denar to the euro to ensure stable and low inflation. The robustness of the peg will be underpinned by using privatization receipts to boost international reserves and by recapitalizing the central bank in order to ensure its financial independence and further strengthen its policy credibility. Supervisory procedures and regulations have already been strengthened in order to contain balance sheet risks that might arise from euroization and rapid credit growth. Further prudential measures to manage banks' balance sheet risks are included in the program," Mr. Kato said.

Background

Despite the success in macroeconomic stabilization under the previous IMF-supported arrangement, which expired in August 2004, economic growth in FYR Macedonia has remained modest. Fiscal discipline has produced a modest and declining debt ratio and the de facto exchange rate peg has brought inflation close to zero, but deficiencies in the functioning of the relevant institutions have undermined business activity and kept per capita FDI low. The resulting weak competitiveness has led to disappointing growth, high unemployment, and a persistent current account deficit.

Program Summary

The new program includes structural reforms to improve the business climate, and thus competitiveness, and sound macroeconomic policies to maintain financial stability. As the structural reforms take effect, GDP growth is projected to accelerate from less than 3 percent per annum in 2003-04 to 4.5 percent in 2007 and the external current account deficit is expected to narrow significantly.

On the macroeconomic front, monetary policy will continue to be based on the de facto peg to the euro, ensuring continued low inflation. The peg will be strengthened by using privatization proceeds to raise international reserve cover from about three months of imports at end-2004 to about four months of imports by end 2006. Appropriate financial policies will maintain reserve cover thereafter. Given recent rapid credit growth—much of it denominated in, or indexed to, the euro—the program aims to mitigate balance sheet risks through strengthened prudential oversight and measures aimed at improving governance in banks.

The fiscal program is anchored by a medium-term deficit target of 0.6 percent of GDP, which will bring the central government debt-to-GDP ratio down to about 33 percent by 2008. The key to reaching the program's ambitious deficit target is a broad-based containment of expenditures, including wages, and the strengthening of tax administration through a carefully sequenced set of reforms. Expenditure management will be improved and reform of the Health Insurance Fund will strengthen government oversight over health expenditure. The program also aims to improve FYR Macedonia's borrowing capacity by developing the domestic debt market and establishing access to international capital markets.

The structural core of the program is a wide range of reforms which should enhance competitiveness by improving conditions for investment and business activity. The new Law on Labor Relations, which strikes a better balance between workers' rights and employers' needs, creates more favorable conditions for business activity by reducing restrictions on short-term and part-time employment contracts and overtime work. Comprehensive judicial reform, to be implemented over several years, will create a fairer and more predictable framework for business activity by increasing the independence and professionalism of judges, eliminating court delays, and removing misdemeanors and administrative cases from the regular courts. The labor market and judicial reforms will be complemented by a number of measures to strengthen the framework for business activity, including, notably, measures to shorten the time needed to open a business. Many of the reforms included in the program are also supported by the World Bank and by other multilateral and bilateral donors.

FYR Macedonia: Selected Economic Indicators, 2003-08

2003

2004

2005

2006

2007

2008

Prel.

Proj.

Real economy

(Percent change)

Real GDP

2.8

2.9

3.7

4.0

4.5

4.5

Consumer prices, (period average) 1/

1.2

-0.3

1.2

1.8

2.0

2.0

Unemployment rate (average)

36.7

35.6

...

...

...

...

Government finances

(In percent of nominal GDP)

Central government balance 2/

-0.1

0.7

-0.8

-0.6

-0.6

-0.6

Revenues (including grants)

38.4

37.5

38.9

35.4

34.1

33.2

Expenditures

38.5

36.8

39.7

36.1

34.7

33.8

Central Government debt

Gross

39.0

37.6

40.9

36.6

35.8

33.4

Net 3/

34.9

33.3

33.5

27.3

25.6

25.0

Money and credit

(Percent change, end of period)

Broad money (M3)

18.0

16.1

17.7

18.4

...

...

Total credit to private sector

19.0

25.0

22.7

19.1

...

...

Short-term lending rate (percent)

14.5

11.8

...

...

...

...

Interbank money market rate (percent)

6.8

8.3

...

...

...

...

Balance of payments

(In millions of Euro)

Exports

1,207

1,344

1,640

1,755

1,893

2,043

Imports

1,961

2,244

2,517

2,636

2,792

2,958

Trade balance

-754

-900

-877

-881

-899

-915

Current account balance

excluding grants

-231

-396

-345

-287

-281

-255

(in percent of GDP)

-5.6

-9.4

-7.8

-6.1

-5.6

-4.8

including grants

-142

-343

-288

-242

-244

-202

(in percent of GDP)

-3.5

-8.2

-6.5

-5.2

-4.9

-3.8

Overall balance

20

-25

212

169

125

101

Official gross reserves

715

717

916

1,078

1,190

1,277

(in months of following year's imports of goods and services)

3.3

2.9

3.6

4.0

4.1

4.1

External debt to GDP ratio (percent) 4/

42.4

44.8

46.7

44.9

44.6

43.9

Exchange rates

(Percent change, period average)

Real effective exchange rate (CPI-based)

2.7

-1.8

...

...

...

...

Real effective exchange rate (ULC-based)

-1.1

1.1

...

...

...

...

Sources: Data provided by the authorities; and IMF staff projections.
1/ Recent revisions by the State Statistics Office have not been incorporated in this document.
2/ 0.4 percent of GDP of the 2005 fiscal account deficit is caused by the NBRM recapitalization.
3/ Gross debt minus government's deposits with the NBRM.
4/ Total external debt, including trade credit. Includes for 2005 an €150 million Eurobond issuance.